The Need For CFOs To Be Dynamic In Their Cash Flow Planning

5 mins read

Fatihah Ramzi, DigitalCFO Asia | 6 December 2022

With an inflationary climate, increasing interest rates, decreased customer demand in a global slowdown and higher labor costs in a tightening market, what can the CFOs do to manage the effects of these problems on cash flow?

CFOs must be nimble to meet the demands of their cash flow planning given the ominous economic clouds that lie ahead. Many businesses have recently been plagued by the “Too Much Inventory” problem. Market volatility, excessively optimistic sales forecasts, customer dissatisfaction anxiety, a flight to “safety stock” brought on by supply chain disruption, and previous organizational responses to consistently high inflation all contribute to the problem.

It is no surprise that operating and cash flow margins are being squeezed and liquidity discussions are becoming more crucial when one considers the inflationary climate, increasing interest rates, decreased customer demand in a global slowdown and higher labor costs in a tightening market.  So, what can the CFOs do to manage the effects of these problems on cash flow?

The need for a more dynamic approach to cash flow management is highlighted by these advances, which CFOs must coordinate with a wide range of organizational stakeholders, internal and external data sources, information systems, and cutting-edge technology solutions. Many companies have chosen to increase prices in order to pass on to customers the increasing expenses of manufacturing, shipping, and talent. Many clients have hit that critical threshold as they are postponing and/or lowering their purchasing activity, and that technique will continue to work until it doesn’t.

Leading CFOs are addressing demand-side concerns by increasing the sensitivity of cash flow management, which includes planning and forecasting, to both internal and external variables. Understanding the factors that contribute to ineffective demand planning, the dangers associated with it, and what promotes effective cash flow planning are necessary for this.

Many businesses and finance departments have spent a lot of time, thought, and effort updating antiquated solutions to supply chain risk management in response to disruptions and flaws that predate the worldwide epidemic. Similar changes are needed on the demand side of the economy as a result of ongoing market volatility and uncertainty because higher prices and rising interest rates influence consumer purchasing decisions. Along with that, the increased risk of customer credit and raised cost of capital have negative effects on capital expenditure planning and strategic investments.

Finance groups benefit from deeper, more immediate insights into the trends and forces affecting cash flow thanks to dynamic cash flow management. This transparency enables CFOs to make sure that business partners across the organization focus on more than just the P&L statement and capital planning, and instead handle cash flow in a way that supports organizational resilience in the face of unpredictability. Such methods of cash flow planning comprise:

  • Working capital analytics: These insights go beyond standard DSO, DPO, and DIO analysis to identify trends impacting receivables, payables, and inventory that support actionable intelligence to enhance working capital and cash conversion. The collection effectiveness index (CEI) can be calculated by finance departments to evaluate chances to increase client collections. Analyzing the proportion of high-risk accounts offers further insight into the factors that affect receivable performance as well as the make-up of the customer base, which should help with credit risk management. By comparing discounts provided and received, a company may be able to benefit from early-pay discounts or gain more insight into lost chances.
  • Scenario-based planning: Finance organizations can minimize financial risks and improve cash management by employing just a few important variables connected to the macroeconomic conditions (for example, interest rates) and company-specific drivers (for example, swings in consumer demand). A competent scenario plan recognizes connections to specific outcomes, such as the need for or decrease of external finance or the implementation of cost-cutting measures that have an impact on fixed or variable expenses. Making better educated investment, financial, and operational decisions requires CFOs and business executives to analyze and compare various cash flow scenarios. Notably, one in three firms are improving and/or expanding scenario planning to manage concerns resulting from inflationary patterns in the market.
  • Stress testing: Running “what-if” scenarios helps firms quickly adjust to shifting market conditions while illuminating best and worst case situations. CFOs frequently use a scenario-driven methodology to examine how different economic hypotheses may affect a company’s operations or a portfolio of investments. Finance teams execute numerous simulations for various probable and severe scenarios, starting with a baseline projection for the most likely outcome, to create a probability distribution of economic outcomes. By detecting prospective changes to the cost of capital and illuminating which investments should be scaled back depending on a specific increase in interest rates, these assessments can also assist capital planning.

Along with other economic, supply chain, and ESG-related factors, leading finance organizations also factor product profitability data, inflation-adjusted data, debt and equity strategies, currency exposures (and mitigation plans), and workplace planning strategies into cash flow planning. Such initiatives produce more useful outcomes. One possible outcome of product profitability assessments is the rationalization of SKU products, which can free up inventory, lower expenses, and even reveal completely unproductive client connections.

A dynamic cash flow management capability necessitates new partnerships, accompanying technology, and frequently, a new way of thinking. Sales partners and other finance clients frequently think in terms of P&L. Excess inventory and the business actions that led to it are probably not costs from the perspective of cash flow. A cash flow perspective enables business partners to comprehend how decisions they make eventually impact how operations are funded and even the outcome of major initiatives.

CFOs should ask for access to more data sources across the company as they broaden and strengthen their relationships with more business stakeholders on cash flow management-related projects. In order to better understand changing consumer needs, demand planning, sales, and marketing departments should improve their interactions with finance organizations. In order to manage changes to short- and long-term strategies to manage cash, investments, debt, and foreign currency exposures, treasury groups should keep CFOs aware of their work with banking partners.

To monitor debt parameters and covenant computations, as well as to comprehend the cash flow effects of planned capital projects and strategic initiatives, finance and treasury should also work closely together. The finance group may guarantee that the appropriate tools and insights are available to implement new cash flow planning models by working with data analytics teams and the IT department.

The yearly planning and budgeting processes that are currently under way in many businesses present a good opportunity for CFOs. While engaging business partners in the finance group’s ongoing drive to analyze and access greater data that is stored outside of the CFO’s direct control, they should argue for dynamic cash flow management. Making a strong case for the value of a cash flow mindset can help CFOs avoid having insufficient knowledge to prevent declining margins, emerging liquidity problems, and other problems from negatively affecting business performance in the months to come. All in all, it is necessary that CFOs use a more dynamic approach to their cash flow planning if they want to remain strong in the face of market volatility that will continue on even in 2023.